Another Red Flag for Coal Stocks

Coal stocks have bounced back from a low point in recent weeks but the industry still faces a myriad of challenges going forward. Domestically, there's little argument that coal demand will decline in coming year, the only question is -- by how much?

Estimates are that as many as 175 coal plants have already been closed in the past four years and more are on the way. The Union of Concerned Scientists, a liberal group that educates on climate change and other causes, issued a report this week that said, "as many as 353 coal-fired power generators in 31 states are no longer economically viable."

The report should be taken with a grain of sale, as should any report with an agenda behind it, but the point is valid nonetheless. Coal is no longer a growing energy source domestically.

Coal is yesterday's energy
When a new plant is built there is usually an intended life of 30 years. After that point maintenance costs go up, technology becomes outdated, and the plant becomes less economically viable. This is what is happening to the coal fleet in the U.S. The plants identified as ripe-for-retirement are on average 45 years old and they're operating at just 47% capacity.

The problem with this for coal companies is that aging plants aren't being replaced by new coal plants, they're being replaced by natural gas or renewable energy. Just look at the table below to see what a drop-off in coal consumption we've had in the last five years.

US Coal Consumption Chart

US Coal Consumption data by YCharts

Environmental regulations that affect coal negatively and low cost natural gas that has caused utilities to shift away from coal are both here to stay. Coal simply isn't the energy of the future.

Exports won't solve the problem
Some will point to China as the source of demand that will take the place of U.S. coal demand. To an extent that's true, but there are plenty of reasons to think China won't be a growing importer of coal.

The central government recently asked coal companies to keep production growth below 4% because of slowing demand and low prices. Coal inventories more than doubled in October from a year ago. China is able to grow coal production if it wants to, but the idea that exports to China will increase dramatically is a pipe dream.

I also don't believe that China's economy will continue to expand at the rate it has in recent years. Betting on China or any other emerging market to increase coal demand when inexpensive and cleaner alternatives are available is just not something I would do.

Returns get worse
For coal producers, hits to demand affect prices and volumes, which has a negative impact on the potential profit for investors.

You can see in the chart below that returns on capital have been falling dramatically over the past year. James River Coal (Nasdaq: JRCC  ) , Arch Coal (NYSE: ACI  ) , and Alpha Natural Resources (NYSE: ANR  ) have all swung into negative territory after having positive returns on capital to begin 2011.

CLF Return on Invested Capital Chart

CLF Return on Invested Capital data by YCharts

Peabody Energy (NYSE: BTU  ) and Cliffs Natural (NYSE: CLF  ) are both slightly positive but the trends still aren't in the right direction. These two companies have remained profitable largely because they have more exposure to metallurgical coal, which doesn't have the same competitive forces as thermal coal right now.

Foolish bottom line
The macro trends simply aren't in favor of coal companies, even if their stocks look like good values right now. Coal is being replaced by natural gas domestically and even in emerging markets there's a focus on cleaner alternatives to coal.

Despite coal's demise, the swelling of the global middle class will lead energy consumption to skyrocket over the next few decades, and long-term investors know that you want exposure to this space now. We've picked one incredible natural gas company that presents a rare "double-play" investment opportunity today. We're calling it "The One Energy Stock You Must Own Before 2014," and you can uncover it today, totally free, in our premium research report. Click here to read more.


Read/Post Comments (9) | Recommend This Article (6)

Comments from our Foolish Readers

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  • Report this Comment On November 15, 2012, at 2:05 PM, LongCoal wrote:

    Travis,

    If T. Boone Pickens is buying coal and he is a billionaire investor, then chances are he is right and you are wrong. Unless of course you have made billions from investing.

    http://www.bloomberg.com/news/2012-11-14/pickens-sells-north...

  • Report this Comment On November 15, 2012, at 2:31 PM, DougMcClenaghan wrote:

    CLF is positive because it gets 85% of its revenues from iron ore.

    CLF revenue from coal is less than 15%. And the coal that is does mine has a NEGATIVE gross profit.

    Not negative profit, but negative CGS. Every ton they mine, at last quarters prices, they lost money

  • Report this Comment On November 15, 2012, at 3:35 PM, dwillis77 wrote:

    You sir (tha author) are an idiot.

  • Report this Comment On November 15, 2012, at 4:34 PM, dwillis77 wrote:

    Platts reporting that stockpiles in all major China ports have decreases and they are in desperate need of Coal.....Fast. So much for for that caca export theory.

  • Report this Comment On November 15, 2012, at 4:50 PM, Paulson545 wrote:

    Dry Bulk shipping rates are dropping , which should increase the profits of coal companies that ship coal overseas. I agree with Travis, T Boone Pickens bought 275,700 shares of Arch Coal . Congress needs to stop using corn for fuel with 47 million Americans on food stamps; when coal can be turned into transportation fuel and diesel.

  • Report this Comment On November 15, 2012, at 4:57 PM, NOISYDEADHEAD wrote:

    its a shame this administration policy on coal...im long aci....but wondering if there is a come back for the industry...can ever aci anr see 10$ a share again..??/

  • Report this Comment On November 15, 2012, at 7:59 PM, TMFFlushDraw wrote:

    @LongCoal

    Look at the performance of the stocks Pickens sold in the article you referenced. These stocks have done mediocre at best over the past year. I don't know what his cost basis is, but these stocks haven't done well.

    Also, put in perspective the tiny bet he made on coal. $1.5 million into ACI is nothing for him.

    If I'm wrong I'll happily admit it. But my record on coal this year has been pretty good. My record is all you can go off of.

    http://www.fool.com/investing/general/2012/04/05/its-time-to...

    Travis Hoium

  • Report this Comment On November 17, 2012, at 7:46 AM, jg215 wrote:

    You state:

    Domestically, there's little argument that coal demand will decline in coming year...

    Did you factor in to your analysis the fact that last week EIA came out with a report saying that coal's share of US energy production is expected to increase from 37.5% to 40% in 2013?

  • Report this Comment On November 19, 2012, at 7:32 PM, Paulson545 wrote:

    Here's a Green Light for coal stocks. T Boone Pickens has been buying shares of Arch Coal and George Soros has been buying shares of Peabody Energy. Maybe these two legendary investors have picked the bottom for the coal stocks. jmho

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